Olly Russ

The European dividend outlook

Olly Russ

Although 2020 will likely prove to be a year to forget for income investors, 2021 should see companies free of restrictions and awash with capital to return to shareholders.

It is said that predictions are difficult, especially about the future, and never more so than now. An epidemic itself is not out of investors’ experience – we have seen SARS and Swine Flu in recent times, for example. Never though have we seen countries deliberately shutter their entire economies in this fashion. What effect this may have had on viral transmission will no doubt be debated for years to come, but the effect on economies has been severe.

Without doubt, the world is looking at the most severe recession in modern times, with all that this entails in terms of destroyed jobs, wealth and businesses. The fiscal damage caused by varying personal and business bailouts will dwarf the global financial crisis. The corporate response to a downturn in demand has to be to lower costs, which unfortunately means unemployment will rise sharply. This reduced personal spending power will have a long-term negative effect. This excess debt is forecast to take the UK and Europe to around 100% debt-to-GDP ratio.

On the more positive side, as the recession itself was to a large degree artificial and self-inflicted, the bounce-back should be relatively swift once restrictions are lifted. Nonetheless, it seems as if it will be the end of 2022 before European economic output once again reaches the level of January 2020.

Unlike the 2008 global financial crisis, this current recession is not the result of a credit crunch. Banks entered this downturn in relatively good shape, having accumulated capital over the last decade, albeit not necessarily due to prudent management but rather under government orders. As a result, and aided by various government guarantee schemes, there should be no shortage of available funding during the recovery phase.

More than ever, investors need to focus on companies with secure balance sheets and the financial robustness to weather the immediate storms and survive into the potentially more profitable and less competitive landscape beyond. Dividend-paying companies are normally at the forefront of this, but the signalling power of dividends is reduced in this crisis.

European dividend season is very heavily focused in the spring, when payouts are made from the previous year’s earnings. Unfortunately, this coincided with peak corona-panic this year. Dividends were cancelled, reduced, postponed or suspended with varying reasons, including ECB or government suasion, the impact of falling earnings or simply prudence on the part of companies’ management teams.

The net effect of all this will be to reduce the dividend-paying ability of Europe temporarily, in common with the UK.

As managers of income funds, we are faced with a heavily disrupted payment outlook. Whilst there are mitigating steps we can take, it seems likely that there will be a reduction in the overall income level this year, given the severe impact of the crisis on corporate profits and dividends.

Looking at those income stocks that have so far been able to navigate the crisis relatively well, it is unsurprising that healthcare stocks feature prominently. Whatever happens in the future, it seems health budgets will rise worldwide, and stockpiling of medical equipment and medicines will become more prevalent, as politicians give the stable door a good slam. Swiss company Roche has hit the headlines with its testing kits for coronavirus, which will no doubt see brisk demand for the foreseeable future. It paid its (increased) dividend as usual in March, as did Novartis and hopeful vaccine contender Sanofi in May. All three companies are expected to raise payouts again next year.

 

By contrast, with the ECB effectively forbidding capital distributions until at least October, banks have been rather frustrated at not being allowed to pay dividends when they regarded themselves as ready, willing and able to do so. For example, ING announced that the 2019 dividend it expected to pay this year has not been added back to capital, showing that it still intends to distribute it when allowed.

 

Fortunately, none of the companies we own have so far seen their ability to pay permanently impaired, and many have already paid and will continue to pay as normal. Of those to have suspended payments we have reason to believe that some – especially in the case of stocks in the financials sector – will pay the missing dividends, at least in part, later in the year.

For a comprehensive list of common financial words and terms, see our glossary here.

 

Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the European Income team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Fund’s expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. Investment in the Liontrust European Enhanced Income Fund writes out of the money call options to generate additional income. These call options will be “covered”. Unitholders should note that potential capital growth of the Fund would be capped if these call options are exercised against the Fund and the Fund’s capital returns could therefore be lower than the market in periods of rapidly rising share prices.

Disclaimer

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Tuesday, June 2, 2020, 1:32 PM